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Rival interpretation of contractual terms

On 29 March 2017, the Supreme Court delivered its judgment in the case of Wood v Capita Insurance Services Limited. The case is a useful reminder of the principles that a court will follow when contractual terms are in dispute.

Background of the case

The case concerned the acquisition by Capita of the share capital of a company, which was in the business of selling car insurance.

After completion of the purchase, Capita discovered that the company had mis-sold insurance to its customers. Customers had paid higher premiums by either the company informing them that the underwriters had required a higher premium, or that the customer had a worse risk profile than in fact was the case.

Capita and the company were obliged to inform the then FSA (now FCA) of the discovery. The company was then required to pay compensation to customers affected by the mis-selling.

Capita sought to recover its alleged loss from Mr Wood (the main seller of the shares in the company to Capita) by relying on an indemnity given by the sellers in the share purchase agreement which related to claims or complaints registered with the FSA which concerned the mis-selling of insurance.

Key issues

The issue was that the terms of the indemnity had two competing interpretations. On the seller’s interpretation the indemnity was not triggered. On Capita’s interpretation, it was.

Lord Hodge, giving the judgment of the court, summarised the legal principles and well-known case law in this area which a court would need to consider to interpret to contract. He said that a court has the task of ascertaining the objective meaning of the language of the agreement. This was not an exercise which focused only on the words of the particular clause but also on the contract as a whole.

He explained that where terms have opposing meanings, the interpretation which is more consistent with business common sense can be given more weight. A court must also consider the quality of the drafting of the disputed wording and be conscious of a party having agreed to the wording which on reflection was not in its interest. The court shall also note that the wording of the clause in question may be the result of a negotiated compromise or due to the parties not being able to agree more precise terms.

Lord Hodge explained that there was a need to engage in a repetitive process of taking each suggested interpretation and checking it against the agreement’s provisions and the commercial consequence investigated. The court should consider both the wording of the agreement and its context. Each such approach is not to be favoured over the other. Both are tools used to ascertain the objective meaning of the disputed wording. These tools will assist in this aim to varying degrees. In some cases analysing the text primarily will be appropriate especially where the agreement is sophisticated, complex and was negotiated by skilled professionals. By contrast, in other cases emphasis would be placed on the context of the agreement. This could occur where the agreement was brief, informal or not drafted by professionals. It was also noted that even in professionally drafted agreements emphasis on context would especially be required where the relevant wording was drafted under deadline or as a result of compromise.

In application of the principles of interpretation the Court examined the indemnity in detail. It concluded that Capita’s suggested interpretation of it was remarkable and unlikely.

The court considered the context of the wording and consequences of the competing interpretations. On one hand the purpose of the wording of the indemnity was to protect Capita against losses resulting from mis-selling. However, on the other hand based on the seller’s interpretation, customers of the company would have needed to make a claim or complaint against the company in order for the indemnity to be triggered. In this case, however, the company was obliged to and informed the FSA of the mis-selling, and the complaint was not made by a customer of the company.

The court noted that the share purchase agreement contained detailed warranties and the indemnity needed to be considered in that context. It concluded that the warranties probably covered the situation which occurred. In reaching its decision the court commented that under the warranties Capita had two years to examine the company’s practices, uncover any mis-selling and make a claim under the warranties. It concluded that whilst Capita may have entered into a poor bargain it was not the court’s function to improve it.

The need for careful drafting

It goes without saying that this case serves as a reminder of the need for careful drafting. In this case the wording of the indemnity from Capita’s perspective, as the buyer of the shares in the company, was not drafted widely enough and did not cover the situation where the company had to report itself to the then FSA.

In drafting important clauses such as indemnities, parties would be well advised to follow the Court’s approach to contractual interpretation and subject the wording to careful analysis and consideration of its commercial consequences to try and ensure it meets with the parties’ expectations.

Relying on the indemnity would likely provide greater recovery than the warranties. The existence of the warranties provided Capita with the ability to make a claim under them. If the warranties had not existed perhaps the court would have arrived at a different conclusion. However, no well advised buyer is likely to be prepared only to rely on an indemnity to cover the potential loss in question.